Author Topic: Seeking Definitive Answer to Fundamental Roth Conversion Question  (Read 2974 times)

drtownhouse

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The easiest way to ask the question is as a simple case study:

Jane has made $100,000 of contributions into her 401k. Her contributions have earned $50,000, so her total balance at retirement is $150,000. She retires from her job and immediately rolls her 401k into a traditional IRA. Assume she converts all $150,000 to a Roth IRA so she can access it in 5 years (Note: aware that nobody would do this given that you only need to convert the amount you intend to spend per year, 5 years from now).

In 5 years, is she only able to access the $100,000 in contributions she had originally made, or can she access the full $150,000. Let's ignore taxes paid or the sake of simplicity?

I am yet to see a definitive answer, though most seem to indicate you can access the full $150,000. That makes sense, given that you already paid taxes on all of it.

Is there a definitive source that verifies this in plain English?

dandarc

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #1 on: January 12, 2015, 07:13:18 PM »
The full 150K - the conversion turns it into a regular contribution after 5 years.

http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000231057

Quote
Additional Tax on Early Distributions

If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions as explained in the following paragraphs.

Distributions of conversion and certain rollover contributions within 5-year period.   If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions , later, to determine the recapture amount, if any.
 
The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution is separately determined for each conversion and rollover, and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions , earlier.
 
For example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2013, and makes a regular contribution for 2012 on the same date, the 5-year period for the conversion begins January 1, 2013, while the 5-year period for the regular contribution begins on January 1, 2012.
« Last Edit: January 12, 2015, 07:16:40 PM by dandarc »

Indexer

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #2 on: January 12, 2015, 07:13:32 PM »
IRS.gov would be the definitive source on this.

I can tell you that you are correct.  The whole 150k is available after 5 years.

I know you already addressed this, but for future readers...  If you convert the entire 150k at once you are going to be in a high tax bracket. 

Instead do 30k this year, 30k the next year, etc.....

Fast forward 5 years and you have a 30k a year tax free income stream.  However you will have an easier time staying in a lower tax bracket throughout.
« Last Edit: January 12, 2015, 07:15:21 PM by Indexer »

maki

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #3 on: January 13, 2015, 02:50:11 AM »
dandarc +1

drtownhouse

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #4 on: January 13, 2015, 04:10:32 PM »
The full 150K - the conversion turns it into a regular contribution after 5 years.

http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000231057

Quote
Additional Tax on Early Distributions

If you receive a distribution that is not a qualified distribution, you may have to pay the 10% additional tax on early distributions as explained in the following paragraphs.

Distributions of conversion and certain rollover contributions within 5-year period.   If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions , later, to determine the recapture amount, if any.
 
The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution is separately determined for each conversion and rollover, and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. See What Are Qualified Distributions , earlier.
 
For example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2013, and makes a regular contribution for 2012 on the same date, the 5-year period for the conversion begins January 1, 2013, while the 5-year period for the regular contribution begins on January 1, 2012.

At risk of sounding dumb, can someone point to the sentence which states that earnings from 401k that are converted to a roth IRA count as principal that can be withdrawn after 5 years of seasoning?

dandarc

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #5 on: January 13, 2015, 04:19:33 PM »
You can withdraw from your Roth IRA at any time - the only question is whether you will have to pay the penalty 10% tax or not.  Paragraph from IRS website says that only if you withdraw the conversion within 5 years of making the conversion do you pay the 10% penalty tax.

skyrefuge

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #6 on: January 13, 2015, 05:07:47 PM »
At risk of sounding dumb, can someone point to the sentence which states that earnings from 401k that are converted to a roth IRA count as principal that can be withdrawn after 5 years of seasoning?

I don't think you'll find that exact sentence anywhere. But that doesn't make it any less true.

A Roth IRA simply has no mechanism to keep track of the portion of a conversion that came from contributions vs. the portion that came from earnings. Think of the Roth conversion as a benign form of money-laundering. Once you perform the conversion of deductible money from a tIRA (and pay the taxes), the details of where that money came from is scrubbed and forever lost. The Roth simply sees the entire $150k as "a conversion".

IRS From 8606 is the form to track Roth conversions and distributions. There is a whole lot to track there, over many years, but nowhere will you find a line where you're supposed to write "the amount of the conversion that came from earnings on tax-deductible contributions". Without requiring that information, there's no way for it to be tracked and differentiated from other money for the purposes of distributions.

You can withdraw from your Roth IRA at any time - the only question is whether you will have to pay the penalty 10% tax or not.

To be pedantic, there is also a question of whether you'll pay income tax on the distribution in addition to the 10% penalty. However, the only time you'll pay income tax plus the 10% is when you take a non-qualified (pre-59.5) distribution of earnings, which are the last thing to be tapped in the distribution order.

drtownhouse

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Re: Seeking Definitive Answer to Fundamental Roth Conversion Question
« Reply #7 on: January 13, 2015, 06:38:25 PM »
Thanks everyone. Benign money-laundering...I like it. Better than light treason, I suppose.